Indian Outsourcing Companies Think Strategy Even as Pressure Mounts

In October, NBC picked up a full season of a sitcom about a Kansas City company that moves jobs to a call center in India and sends an American manager to head the operations there. “Outsourced”, which according to Nielsen TV ratings attracted over 7 million viewers when it premiered September, is a rare comedic depiction by mainstream media of a sensitive political and economic issue.

In India, however, the state of the outsourcing industry is not provoking any laughter. The United States accounts for 61% of the revenues of the country’s IT and ITeS (IT-enabled services, essentially business process outsourcing — BPO) export market, according to the National Association of Software and Service Companies (NASSCOM). But Americans continue to believe that outsourced Indian call centers and back offices are taking away their jobs; according to a Wall Street Journal/NBC poll released in September, 86% of respondents said outsourcing was the primary cause of America’s economic duress. With unemployment hitting 9.8% in November, a change of mood doesn’t seem likely.

It’s not just attitudes that are affecting the outsourcing industry. The recession over the past few years has forced many U.S. companies — particularly in the finance sector — to cut costs. And though outsourcing to India may be the more economical option, political pressures have meant a slowdown in order flow from America. There are problems at home too — including rising costs and a shortage of talent. So is it time to write an epitaph for India’s BPO sector?

Not necessarily, according to Wharton management professor Saikat Chaudhuri, who characterizes the current challenges as a passing phase. “The recession and government policies are temporary obstacles that might change with another administration,” he notes. “Let’s say the economy starts to grow again, job pressures ease and people start feeling better about the situation. They won’t want to hurt the competitiveness of U.S. firms, so things will change again. I see these as normal changes that the media is blowing out of proportion. It’s like a few years ago when the Indian Rupee was appreciating really quickly. The entire outsourcing industry was complaining. If you can’t handle this, you shouldn’t be in the business.”

Ananda Mukerji, vice-chairman of Firstsource, one of the few listed BPO companies in India, agrees that it is too early to write off the BPO story. “The BPO industry is less than a decade old,” he points out. “Compare that to the IT industry, which took many more years to reach this size and scale. We have billion-dollar revenue companies like Genpact; it took much longer for TCS, Wipro and Infosys to reach half a billion dollars. It’s still early in the industry and there is a very large opportunity.”

While NASSCOM president Som Mittal notes that BPO growth was in single digits for the first time in FY2010 (the financial year ended March 31, 2010) after years of high-velocity expansion. Yet he believes that “most companies used the period of recession to retool themselves and re-skill their employees in preparation for the period when the winds will blow over.” According to NASSCOM figures, the size of the BPO market in FY2010 was US$12.4 billion and the growth rate 6%. The total size of the IT-BPO industry was US$73.1 billion.

Experts are unanimous on the principal strategy that will help providers thrive amid a changing environment — specialization. “The companies that will survive will move higher in the value chain, from peripheral activities to increasingly core activities of clients,” Wharton’s Chaudhuri says. “At some point, even Infosys and TCS [both of which have significant and growing BPO operations] will have to start getting US$5billion-over-five-years deals as IBM and Accenture do, otherwise it will be very hard for them with [competitors] constantly at their heels.”

Chaudhuri warns that India’s initial and obvious advantages in the outsourcing sector — labor arbitrage, lower cost of operations and a workforce that is fluent in English — are not sustainable in a growing economy. “While lower cost can remain as some sort of advantage, it will keep diminishing,” he notes, recommending that firms shift their source of competitive advantage to specialized expertise. “That’s what will ensure their success in the long run…. But nothing is a goldmine. I can’t think of very many industries where you can just turn on the tap and get the same returns year on year without doing anything.”

No Longer a Commodity

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According to Chaudhuri, the BPO-as-commodity era is over, at least for India. “Work is going to becoming increasingly higher end, and that’s what makes KPO [Knowledge Process Outsourcing] most exciting,” he adds.

Jui Narendran, business head (sourcing practice) of market research firm Value Notes, describes KPO as services that “constitute certain specialized functions like financial services, legal and publishing outsourcing, some parts of training and education outsourcing as well as high-end analytics including insurance, finance and banking.” Value Notes estimates the size of the KPO market in India at US$5.95 billion in 2010-2011. It will reach US$10 billion by 2013, growing faster than traditional BPO, Narendran predicts.

Indeed, many Indian BPOs realized early on that their clients would eventually outgrow a need for only the basic bread-and-butter services. But the BPOs approach was to try and provide the additional expertise within their existing infrastructure. Most knowledge processes — in the legal, engineering and medical fields for instance — require different corporate cultures and support systems. The education levels of employees need to be higher; the salaries are necessarily more. The average BPO worker won’t necessarily fit into a KPO framework, experts say. Thus, it took some time for KPO services to evolve. The problems clients experienced in this learning period gave rise to some doubts.

“I was very skeptical about using an Indian LPO [legal process outsourcing firm],” notes Habib Nasrullah, a partner in the Denver, Colorado-based civil litigation law firm Wheeler Trigg O’Donnell LLP. “Lack of expertise is a big fear since we can get sued for the errors and omissions of our vendors. Clients are skeptical about it and the cost differential is sometimes not worth the risk.” But three years into his relationship with the Pune-headquartered LPO Bodhi Global Services, Nasrullah is impressed with the sophisticated technology and global workforce that India has to offer, a far cry from the early days of call center grunt work.

KPO comes in a variety of hues; not every sector will prove equally profitable. According to Arihant Patni, founder and director of Bodhi Global, the hot spots are in legal processes, architectural design, engineering design and application development for gaming and mobile devices. The last is practically virgin territory, he says, and has the potential for explosive growth.

Another element of strategy for BPO firms is the development of relationships. This is true of all businesses of course. But unlike in traditional BPO, KPO could often involve mission critical functions. “It’s all about the relationships,” says Nasrullah. “I know the people well and know the quality they insist on delivering.” Partnering with the right domain experts in these specialized fields may add significantly to the level of service. For instance, Bodhi Global is co-promoted by AZB & Partners, one of India’s leading law firms. This could raise client confidentiality issues in the future as business expands. But the LPOs are getting over that for now by setting up captive centers for companies.

Relationships Matter More

These moves underline the fact that the relationship between an outsourcing firm and its client needs to be more than that of a simple service provider; the BPO needs to be a partner in the process. “That requires innovation on processes and building insights around them so we can go back and tell the customer something about the process even he doesn’t know,” notes Tiger Tyagarajan, COO of Genpact, India’s largest BPO. “It will increase your pricing power, customer value and profitability. Companies that look at end-to-end processes in partnership with customers and drive better outcomes on those processes are going to win.”

For Genpact, the fastest growing sector is the company’s US$150 million analytics business. NASDAQ-listed EXL Service, which has its India corporate office in Noida near Delhi, has created its own efficiencies across verticals. In insurance, the firm has moved from doing mere data entry work to actuarial services. For utilities client British Gas, it has become a “strategic partner in the design of their backend. That’s how well we understand their business and how specialized we are,” says EXL president and CEO Rohit Kapoor. According to Kapoor, the outsourcing industry globally is moving toward more “structured transactions, where companies are looking for total outsourced solutions, resulting in different types of models.”

Indian BPOs also have to get out of the mindset that they are Indian, experts say. In a globalized world — and given the economic environment in the West — onshoring should be given as much importance as offshoring; outsourcing does not mean a service has to be done out of the country. T.J. Singh, research director at IT research and advisory company Gartner, recently reviewed a contract for a U.S. client that specifically requested delivery of services onshore. “My question to Indian providers is: Why look at just India? Companies need to understand that the BPO strategy is bigger than the offshore game.” Singh advises companies to drive higher levels of automation to take as much of the labor equation out of the process as possible. “Work-at-home is starting to grow. If you want to be a key player globally, you need an onshore presence,” says Singh. “I think outsourcing will grow, but whether offshoring will be a big part of it is a still a question.” He believes that the time is right to look at onshore capabilities in North America. “It’s a weak dollar, valuations are good and there are opportunities in M&A and acquisitions,” he adds. “It’s cheaper to buy today than build.”

M&A should be a strategy within India too, says Wharton’s Chaudhuri, who recommends that firms, especially smaller ones, “think about preemptively merging to achieve a certain scale.” Value Notes’ Narendran cites Aegis as a classic example of a company that has made a large number of acquisitions (including several abroad) in recent years. “These acquisitions have been very targeted. [They are in] specific geographies and skills and are indicative of the global delivery model strategy most companies are following.” M&A is of course far more relevant to BPO than KPO. But it is possible to visualize, say, legal firms dotted around the world coming under one umbrella. Legal work may require country-specific skills, but there is a lot that is common too, experts note. With globalization that only expected to increase, not decrease.

Wharton’s Chaudhuri adds another dimension to this globalization drive. He says that firms need to diversify from the U.S. market. “Why don’t you go to Brazil, China, the African countries, the Middle East, Australia?” he asks, noting that many of these are countries that are rapidly increasing their share of the global economy. “Look how quickly GE and IBM bounced back from the economic crisis. If you look carefully at their numbers, their revenue and growth is coming from emerging economies.” If Indian companies don’t realize this, Chaudhuri warns, they could get left behind. Gartner’s Singh cites the example of Indian telecom company Bharti’s acquisition of African group Zain. “Who’s their partner? IBM. Why wasn’t it Wipro or any of the Tata companies?,” asks Singh, who says the answer is that IBM has a much bigger presence in Africa than any of the Indian majors.

There is another market Indian companies need to explore, experts say — India itself. Like the IT companies before it, the BPO sector initially pursued the low hanging fruit — the U.S. and other Western countries where they get paid more for their services. The firms have ignored the domestic market, where volumes are high and growing, but margins are low. This is clear from the pecking order. The three top BPOs in India are Genpact, WNS Global Services and IBM Global Process Services. Genpact was originally a business unit within GE that was farmed out as an independent company in January 2005. WNS started life as a captive of British Airways and now has Warburg Pincus as its principal shareholder. IBM Global was originally Daksh eServices, which was acquired by IBM in June 2004. These are the companies that have been dominating the domestic BPO arena. According to NASSCOM, the domestic BPO segment has continued its strong performance over the past few years, growing by 22% in FY 2010 over FY2009, to reach US$2.2 billion. Observers expect Indian companies to become more active here as has happened in IT software and services.

The View from the Other Side

But there are some who believe that the KPO strategy may fail Indian outsourcing companies. Firstsource’s Mukerji is upbeat about BPO as a whole, but he is skeptical about the scalability of KPO. “Outsourcing makes sense and goes beyond labor arbitrage to where you can really standardize processes, where you can break up a process into finite elements and then execute those with a high degree of predictability, repeatability and efficiency,” he says. “KPO is a good business, but it is clearly not scalable to the order to which the BPO industry has scaled. They are peripheral to the entire industry. You can never have a billion-dollar equity research company.” According to Genpact’s Tyagarajan, KPO firms grow rapidly and make money until they hit a wall and margins start deteriorating dramatically.

To some, BPO’s safest strategy may be sticking to sectors that are growing and living with low-end work. “I’m having a tough time thinking of a sector that won’t do well,” says Wharton’s Chaudhuri, although he named engineering, health care, drug development and education as expected high growth sectors. Health care, financial services and telecom are the choices of Firstsource’s Mukerji, while EXL’s Kapoor would put his money on insurance with smaller bets on banking and health care.

No matter where companies choose to focus, however, innovation is key, says Chaudhuri. “Things are changing and that’s what’s exciting right now. If you’re heavily reliant on status quo in anything in the world right now, then you deserve to go out of business.”